26/05/2010 - Economic activity in OECD countries is picking up faster than expected but volatile sovereign debt markets and overheating in emerging-market economies are presenting increasing risks to the recovery, according to the OECD’s latest Economic Outlook.

Gross domestic product (GDP) across OECD countries is projected to rise by 2.7% this year and by 2.8% in 2011. These are upward revisions from the previous, November 2009, forecasts of OECD-wide GDP growth of 1.9% in 2010 and 2.5% in 2011.

In the US, activity is projected to rise by 3.2% this year and by a further 3.2% in 2011. Euro area growth is forecast at 1.2% this year and 1.8% next while, in Japan, GDP is expected to expand by 3.0% in 2010 and by 2.0% in 2011.

OECD

Trade flows are rising again. Strong growth in China and other emerging markets is helping to pull other countries out of recession. But at the same time, the risk of overheating and inflation is growing in emerging markets. A boom-bust scenario cannot be ruled out, requiring a further tightening in countries such as China and India. The knock-on effect would be slower growth in other regions. Exchange rate flexibility could ease some of the pressure on Chinese monetary policy and provide more scope for addressing domestic inflation, says the OECD.

Instability in sovereign debt markets poses another serious risk. It has highlighted the need for the euro area to strengthen its institutional and operational architecture. Bolder measures need to be taken to ensure fiscal discipline, says the Outlook.Several countries are already taking early action to enhance the credibility of their fiscal consolidation plans and this is very welcome.

“This is a critical time for the world economy,”said OECD Secretary-General Angel Gurría. “Coordinated international efforts prevented the recession from becoming more severe but we continue to face huge challenges. Many OECD countries need to reconcile support to a still fragile recovery with the need to move to a more sustainable fiscal path. We also need to take into account the international spill-overs of domestic policies. Now more than ever, we need to maintain co-operation at an international level.”

With a huge debt burden weighing on many OECD countries and the strengthening recovery, the emergency fiscal measures provided by governments to tackle the crisis must be removed by 2011 at the latest, the Outlook says. It adds that the pace of such action must be appropriate to particular conditions and the state of public finances in each country.

OECD

To support growth as budgets are being tightened, macroeconomic, financial and structural policies need to be linked. Spending cuts or tax rises should focus on areas that are the least harmful to growth. Fiscal rules could enhance the credibility of plans to strengthen public finances. Reforming product and labour markets to enhance competitivity must also be part of the strategy.

Although economic activity is picking up, the growth in jobs is not keeping pace. The number of unemployed has risen by 16 million in OECD countries in the past two years. The Outlook says the unemployment rate may now be peaking at an average 8.5% across OECD economies and is likely to fall only slowly in the near term. It adds that governments must make room in their budgets for cost-effective labour market programmes that support workers at greatest risk of becoming long-term unemployed.

Unemployment rate (% of labour force)

OECD

The Outlook also contains some scenarios that go out as far as 2025, and which show that without strong policy decisions, growth will remain mediocre, unemployment and fiscal deficits high and imbalances persistent. On the other hand, a combined package of measures, implemented from 2011 onwards – involving fiscal consolidation in OECD countries, as well as exchange rate re-alignments and structural reforms in most regions of the world – could add as much as 2 – 3 % to the baseline scenario of OECD global growth.